China's Pressing Need to Buy Gold

December 29, 2009

Without any doubt the fastest growing country in the world is also the largest in many ways. CHINA rightfully claims that title.

In total population China dwarfs all others...in territorial area…it is second only to Russia. Furthermore, China's economic growth - whether measured in annual percent increase in GNP or in absolute total dollar growth is second to none. To be sure the Sino country's export trade (and resulting Trade Surplus) is the envy of its global competitors. Unfortunately, China's exponential growth in Foreign Reserves has fostered a serious problem.

SERIOUS FOREX RISK

China's export trade machine has 'invaded' all countries, especially the USA. This resulted in building up a mountain of Foreign Reserves, denominated mostly in US Dollars. Recent data show China has upwards of $2,273 Billion in Foreign Reserves with about 70% denominated in US dollar (*).

Unfortunately, The Peoples Bank of China did not have the foresight to diversity its mounting Foreign Reserves into other currencies like the euro, yen and gold. Consequently, China will suffer a horrific loss in 2009. The loss is composed in two parts: 1)Dollar devaluation, and 2)Price decline of US Treasuries as most of its Foreign Reserves are in this investment vehicle….rather than gold. The following chart clearly demonstrates the relative total return of the US Dollar, US Treasuries and gold during 2009. As of December 29, 2009):

DIRE NEED TO DIVERSITY ITS FOREIGN RESERVES

It is painfully obvious China has a pressing need to diversify its ever mounting Foreign Reserves derived from its perennial Trade surplus. This begs the question, how much gold does China need relative to its gargantuan level of Foreign Reserves? To objectively answer this, it is necessary to compare China's positions to that of other highly industrialized countries - like the USA, GERMANY, ITALY and FRANCE.

Presently, China has 27 TIMES MORE the total Foreign Reserves of the USA. In fact China has more than 4 TIMES the total Foreign Reserves of USA, Germany, Italy and France, combined !! Here's the data for each:

China is truly the Goliath of Total Foreign Reserves.

However, this Goliath has an Achilles Heel. Only a minuscule 1.5% of its Total Foreign Reserves is gold. Most of the rest is in US greenbacks. Consequently, China is subject to and a slave of the vagaries of the US dollar.

To appreciate the severity of China's FOREX risk, one must compare gold foreign reserves coverage prudently held by the other well developed countries. Namely, what percent of their Total Foreign Reserves are in gold. The following is self-explanatory.

Clearly, China is grossly if not obscenely deficient in diversifying its pernicious US dollar reserves into traditional value storage gold. But what might be a prudent gold diversification for The Peoples Bank of China?

The above four major industrialize countries hold a prudent 65% of their Total Foreign Reserves in gold. If one assumes China may soon recognize the sensible merits of gold's risk diversification, The Peoples Bank of China would need to buy an additional 44,619 tonnes of the shiny yellow. It is imperative to put this quantity into perspective by comparing it to two bench marks:

  • The world's total existing above ground gold is only 166,000 tonnes
  • The world's total yearly mine production is only about 2,500 tonnes

China's gold deficit represents 27% of the total existing above ground gold (166,000). Furthermore, if China were to buy up all newly mined gold in the world, it would take 18 years to accumulate 44,619 tonnes.

CONCLUSIONS

  • China is sorely short in gold reserves as percent of its Total Foreign Reserves
  • To dally in increasing its gold reserves, China will continue to incur grievous losses in its Total Foreign Reserve portfolio
  • China is obliged to implement a continuous accumulation plan to buy gold in the open market from existing holders, and to buy up newly mined gold when available.
  • China's increasing gold needs will grow apace with its relentlessly bigger Trade Surpluses, which rise year after year after year.
  • In light of The Peoples Bank of China's insatiable need for gold reserves, there will NEVER be a peak gold price. To be sure there will be technical corrections when gold rises too much too fast. However, these will only be temporary technical reactions…and will constitute buying opportunities for those investors who have just 'discovered' gold's incredible total return as compared to all other investment vehicles. An example of this is the chart below showing the relative total returns of different investments during the past 9 years (2001 to Present).

It is imperative to appreciate past results is no guarantee of future performance. However, I am convinced future relative performance may be a mirror image of the past nine years. My steadfast conviction is based on the following:

  • President Obama's Stimulus Program(s) is highly inflationary
  • The Fed continues to expand Money Supply and the Monetary base
  • Many country Central Banks are buying gold to diversify their foreign reserves
  • Real interest rates are negative and may remain so for the foreseeable future
  • All the above will continue to pressure the US dollar lower, and conversely gold higher
  • Everyday more new investors are putting their money in bullion and gold stocks
  • It will take China years to accumulate a satisfactory amount of gold as a prudent percent of its growing Total Foreign Reserves. To the contrary, if China becomes too impatient in its gold accumulation, it could cause its price to go parabolic within weeks.
  • The total amount of gold may be considered finite - as the yearly increase in mine supply is a mere 1.5%. Moreover, total gold mine production has been slowly declining for some time. Therefore, where demand relentlessly grows vis-à-vis a finite supply, the price must inevitably and relentlessly rise.

 

ERGO, there will NEVER be peak gold price.

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Data Sources (*):

Total Reserves by Country

http://en.wikipedia.org/wiki/List_of_countries_by_foreign_exchange_reserves

Gold Reserves by Country

http://en.wikipedia.org/wiki/Official_gold_reserves

Founder of GOLD-EAGLE in January 1997. Vronsky has over 40 years’ experience in the international investment world, having cut his financial teeth in Wall Street as a Financial Analyst with White Weld.  He believes gold and silver will soon be recognized as legal tender in all 50 US states (Utah and Arizona having already passed laws to that effect). Vronsky speaks three languages with indifference:   English, Spanish and Brazilian Portuguese.  His education includes university degrees in Engineering, Liberal Arts and an MBA in International Business Administration – qualifying as Phi Beta Kappa for high scholastic achievement in all three.

A gold nugget can be worth three to four times the value of the gold it contains because they are so rare.